UC Irvine
Globalization of I.T.
Title
Market Making in the PC Industry
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Authors
Dedrick, Jason
Kraemer, Kenneth L
Publication Date
2007-03-01
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University of California
Market Making in the PC Industry
Jason Dedrick
Kenneth L. Kraemer
Personal Computing Industry Center
The Paul Merage School of Business, University of California, Irvine
3200 Berkeley Place North
Irvine, California 92697-4650
949/824-6387 Tel.
949/824-8091 Fax
{jdedrick, kkraemer}@uci.edu
March 2007
The Personal Computing Industry Center is supported by grants from the Alfred P. Sloan Foundation, the U.S.
National Science Foundation, industry sponsors, and University of California, Irvine (California Institute of
Information Technology and Telecommunications, The Paul Merage School of Business, and the Vice Chancellor
for Research). Online at http://pcic.merage.uci.edu.
1
Market Making in the PC Industry1
Jason Dedrick and Kenneth L. Kraemer
University of California, Irvine
I. Introduction
Over the past twenty-five years, personal computer makers have been steadily
changing from manufacturers to market makers.
Leading PC makers once
designed and built their own PCs and sold them through a mix of direct and
mostly indirect distribution channels (Dedrick and Kraemer, 1998).2 PCs were
built to forecast, and fluctuating demand led to alternating periods of costly
inventory build-up and product shortages.
Given the rapid depreciation and
obsolescence of PCs and their components, and the common practice of price
protection given to retailers, this production and distribution model was very
costly to PC manufacturers.
This model was severely disrupted in the 1990s by the rise of direct sales
specialists Dell and Gateway (Dedrick and Kraemer, 2005). By selling directly to
the customer and only building products to order, these companies were able to
reduce inventory and introduce new products without needing months to clear
out old inventory in the channel.
Dell’s rapid growth and superior financial
performance in particular put enormous pressure on the rest of the industry,
eventually driving some competitors out of the market and forcing others to
revamp their distribution channels and supply chains. While different models
were applied over the years, PC makers moved to selling direct to the customer
or to working closely with retailers to match supply and demand through
1
To be included as Chapter 10, in Hamilton, Senauer and Petrovic (eds), The Market Makers: How Retailers are
Reshaping the Global Economy. This research is supported by a grant from the Alfred P. Sloan Foundation to the
Personal Computing Industry Center at The Paul Merage School of Business, University of California, Irvine. We
gratefully acknowledge the International Data Corporation (IDC) for providing data for the study and Paul Gray for
comments on the paper.
2
Direct channels include telephone and Internet sales made directly by the manufacturer. Indirect sales involve soles to
distributors and/or retailers.
2
sophisticated marketing, forecasting and supply chain management.
A key
element has been the use of the Internet as a distribution channel and
information technology more generally to streamline processes within the firm
and across the supply chain.
The impacts are greatest in the U.S., where direct sales increased from less than
a quarter to over one half of the market between 1995-2005. The direct channel
is especially important in serving the commercial market,3 where PC makers offer
a variety of services together with hardware to support IT departments in
organizations.
In the indirect channel, aimed at the consumer market, sales
shifted from dealers and specialist stores to larger consumer electronics and
office retailers such as Best Buy, Circuit City, and Office Depot, who now work
closely with PC makers to shape and efficiently fulfill market demand.
The U.S. pattern contrasts with other markets. Worldwide the indirect channel
accounts for two-thirds of sales, and the dealer/reseller segment is larger than
retail. Retail exhibits many different local patterns as a result of local consumer
preferences, government regulations and differences in historical evolution. This
local complexity makes it difficult for branded PC makers to become global
market makers. Instead, branded PC makers such as Dell, HP, Acer, Sony and
Toshiba are forced to adjust their distribution models to fit local markets. Internet
sales in particular are constrained by consumer preferences and by the quality of
IT and delivery infrastructure (Kraemer et al., 2006).
In some country markets, domestic competitors maintain extensive dealer
networks (e.g. NEC, Toshiba and Fujitsu in Japan, Samsung in Korea and
Lenovo in China). Elsewhere, local retailers developed their own store brand
PCs, or collaborated with local companies to act as market makers (e.g.,
Germany, Brazil). In many markets, “white box”4 PCs make up a large share of
3
The commercial market refers to enterprise, SME, governments education and other organizational segments, whereas
the consumer market refers to households and individuals.
4
White box refers to generic PC which carry the brand of the retailer or distributor rather than the manufacturer
3
the market.
In these markets, small local shops build PCs for individual
customers or small businesses. However, while there is a great deal of variation,
the global trend is also towards more direct sales and towards large electronics
retailers taking market share away from specialist dealers and resellers.
Although PC makers have become market-makers, retailing PCs to commercial
customers and consumers, the PC industry offers a different and interesting twist
on the “market makers” theme.
In other industries, retailers used their
relationship with the final customer to gain leverage over brand name
manufacturers. They also developed store brands, essentially coordinating the
manufacturing process even though they do not own any factories themselves.
In the PC industry, major branded manufacturers became market makers in their
own right, primarily by selling directly to the final customer, and also in
collaboration with major retailers. PC makers perform market-making activities
such as targeting markets, defining products, capturing customers, organizing
efficient supply chains, and integrating hardware, software, services and content
to deliver new user experiences. Meanwhile, some retailers have developed
“store” brands, but most have either lacked the ability to compete directly with
brand name vendors, or decided it is not profitable to try to do so.
II. Evolution of the PC industry
Historically, computer companies were vertically integrated, handling all aspects
of manufacturing and distribution.
The introduction of the PC, which was a
modular product whose architecture was open, changed the industry into
horizontal industry segments, each of which specialized in different aspects from
microprocessors to components and peripherals to PC systems to operating
systems and applications to distribution (Figure 1). PC companies designed and
assembled modular systems from components and software developed by
outside suppliers. These systems were distributed through a variety of channels,
including wholesalers, corporate resellers, department stores, electronics
4
superstores, specialty retailers and the vendors’ own direct sales force. The
connection between the PC maker and the final customer was often weak (via
advertising and marketing) or non-existent. This market diversity made it difficult
to match supply and demand, leading to build-up of inventory which is costly
given the rapid depreciation of the product.
Figure 1. Indirect distribution
Component
suppliers
R&D
manufacturing
CM/ODM
Manufacturing
PC maker
Design,
final assembly,
marketing
Distributor
Distribution
Retailer/
reseller
Customer
Sales,
service
Note: CM= Contract Manufacturer; ODM= Original Design Manufacturer5
In the mid-1990s, a major shift began in the U.S. market toward direct sales of
PCs, led by Dell and Gateway. By selling directly to the end customer, the PC
maker was able to respond to demand and also to shape the demand to match
available supply (e.g., by using telesales staff to promote or offer discounts on
products in stock). The direct model also cut out the distributor and retailer,
thereby eliminating two layers of inventory, avoiding costly price protection
guarantees to retailers, and allowing new products to be brought to market
without clearing old inventory out of the channel (Figure 2). The direct model put
the PC maker in the role of “market maker,” with control over pricing and
branding and the ability to bundle a variety of products and services to the
customer.
5
ODMs are mostly-Taiwanese firms that provide manufacturing and design services. Over 80% of
notebook PCs are now manufactured by ODMs. CMs provide manufacturing services to a broad array of
electronics firms.
5
Figure 2. Direct distribution
Component
suppliers
R&D
manufacturing
CM/ODM
Manufacturing
PC maker
Customer
Design, final
assembly, marketing,
sales, service
In the U.S. market, the direct model came to dominate the corporate market, as a
result of the success of Dell and the shift to greater use of direct sales by
Compaq, HP and IBM. The direct model was augmented by e-commerce, as
customers could easily compare, configure and buy PCs online from the PC
vendor, or place the order by phone.
In the consumer market, while many
customers began to buy direct, many still preferred shopping in a physical store.
However, the retail market for PCs changed.
Whereas the indirect channel
dominated with 76% of PC shipments in 1995, direct sales accounted for nearly
55% of all PC shipments by 2005 (Table 1).
Table 1. U.S. PC shipment share by channel (units)
Channel
1995
2000
2005
Direct*
23.79%
41.70%
54.46%
16.02
22.31
17.31
7.77
12.67
24.76
.00
6.72
12.39
76.21
58.30
45.54
Retail
29.76
24.05
21.36
Dealer/VAR/SI
37.32
29.77
19.85
9.13
4.48
4.33
Direct Inbound
Direct Outbound
Internet Direct
Indirect**
Other
Source: IDC, 2006
*Direct sales include: (1) sales by customer-initiated inbound calls, (2) sales by a feet-on-the-street sales force, and sales
by vendor-initiated outbound calls, (3) sales made strictly online directly by the end user with no human interaction from
the vendor.
**Indirect sales are those sold through a distributor, aggregator, system integrator, value added reseller, mass merchant,
or retailer, including vendor-owned retail stores.
6
III. Market-making models in the U.S. PC market
Many variations of market making are used in the direct and indirect models, with
different companies choosing different mixes of the two. Four such variations in
the U.S. PC market are shown in Table 2 and described next.
1. In the traditional channel third party intermediaries supply branded PCs to
business and consumer end users. These intermediaries may be distributors,
value added resellers (VARs), systems integrators (SI) or large merchandisers
(e.g., department stores, large electronic stores, large discount stores).
In
addition, distributors supply branded PCs to the many specialty retailers,
especially smaller ones.
Hewlett-Packard is the iconic illustration of this
variation, but also involves retail collaboration (as described below).
The
traditional channel is the dominant variation used by vendors for many other
related products (e.g., components, peripherals, supplies) whose manufacturers
are too small to deal directly with retailers.
2. Retail collaboration was created by eMachines whose CEO was a former Best
Buy executive.
It is incorporated by Gateway, which bought eMachines and
continues to sell both brands. It involves
x
close collaboration between the PC maker and a few major retailers, using
very sophisticated demand forecasting models to match supply and
demand, and
x
three month product cycles with sell-out at the end of each cycle to avoid
inventory build-up (Ralston et al., 2004).
The market making mechanism is shared by the branded PC maker and the
retailer who cooperate in determining target markets, product design and
advertising programs. The number one consumer PC vendor, HP, reportedly
developed a similar approach in the retail channel for consumer and SME (small
and medium enterprise) markets.
7
Table 2. Comparison of market-making models in U.S. PC market
Characteristics
Channel
Roles
Indirect
Traditional
Retail
channel
collaboration
ReChannel as
intermediation:
intermediary
PC maker and
between
retailer
manufacturer
and the market collaborate in
going to market
Direct
PC maker as
Retailer as
retailer
PC maker
Retailer
PC maker
disintermediates employs
ODMs to
the traditional
make ownchannel and
goes direct to the brand PC
and go to
market
market
Channel
Members
Channels
include large
distributors,
VARs, SIs and
electronics/
discount stores
Channels
include large
retailers
Channels include
vendor sales
force, inbound
and outbound
phone sales,
online sales,
vendor-owned
stores
Retailer is the
channel
Examples
HP and Apple:
IngramMicro,
TechData,
Fry’s, Costco,
Best Buy,
CompUSA
Gateway/
eMachines, and
HP with Best
Buy, Costco,
Office Depot
Dell: web,
telesales,
experimenting
with own stores
Apple: web,
telesales, Apple
Stores
Wal-Mart,
CompUSA,
white box
dealers, with
ODMs/
component
suppliers
Market
Strength
Commercial &
consumer
markets
Consumer
market
Commercial
market
SME,
consumer
markets
3. The PC maker as retailer is the classic illustration of the pure direct sales
model which employs the vendor’s own direct sales force in the field, its own and
third party telesales, and Internet sales to reach customers. It proved especially
attractive to the commercial market, but also caught on with consumers in the
U.S.
The direct model is associated mostly with Dell for the commercial market
(Kraemer et al., 2000) and originally with Gateway for the consumer market
(Dedrick et al., 2001). It is also is used by other PC makers such as Apple and
8
HP.
In this case, the PC maker acts as retailer and market maker and
disintermediates the channel. Direct sales have been expanded by Dell and
Apple to include other electronics products such as big-screen TVs, printers, and
portable music players. The most familiar forms of direct sales are telesales and
online sales, but both Dell and HP have feet-on-the-street sales forces that deal
with large corporate and multinational customers.
The vendor-owned store is a variation of PC maker as retailer.
Although
abandoned by Gateway (Dedrick et al., 2001), it is highly successful for Apple.
Dell is currently experimenting with its own stores. Apple’s success is partly due
to the design and location of its stores, which are generally in high-end retail
malls and districts and do not compete directly with electronics retailers who also
sell its products. Also, retailers cannot obtain Macs or iPods elsewhere, unlike
the Wintel standard PCs, and so they lack leverage with Apple.
4. Retailer as PC maker, the private label brand experimented with by WalMart,
CompUSA and other retailers (Tzeng and Shen, 2005). It also is used by small
local makers who long held a strong position in the small business market.
Although declining, private labels still supply about 20% of the total PC market in
the U.S. and more in developing countries. Retailers can easily source PCs from
contract manufacturers and original design manufacturers, as well as from
distributors who provide final assembly. There is no real barrier to selling private
label brands, yet as of 2007, large retailers in the U.S. have not done much to
develop their own PC or electronics brands, unlike retailers in clothing, tools,
furniture and other products.
Evolutionary patterns of PC makers as market makers
When applied to the branded PC firms in the industry, it is clear that no single
firm fits the direct and indirect models perfectly, although Dell and Gateway were
closest to the direct model and HP and Compaq were closest to the indirect
9
model in 2000. Since then, the companies chose different mixes of the two
models, with their distinct patterns apparent when comparing changes in channel
use from 1995-2005 (Table 3).
Table 3. U.S. branded PC makers as market makers: percent of shipments
by channel (%)
Vendor
Indirect
Retail
Direct
1995
2005
Value-added
reseller/System
integrator
1995
2005
Vendor-direct
sales force &
telesales
1995
2005
Pure Internet &
3rd party
Internet
20001 2005
Apple
36
39
53
13
11
43
7
4
Dell
0
0
0
6
100
67
15
27
Gateway
0
67
1
3
99
25
8
5
HP
20
51
80
21
0
24
2
5
Compaq2
34
-
58
-
8
-
2
-
IBM
30
0
57
51
14
36
6
13
Source: IDC, 2007
1
Note that this column contains values for 2000 rather than 1995. The 1995 values for each vendor add to 100. Internet
sales were 0% in 1995, the year that the Internet was opened for commerce.
2.
Compaq was acquired by HP in 2002. Its 2005 data are included in HP’s results.
The table shows that:
All PC makers listed moved to greater use of direct sales, but indirect sales
still dominate for most companies.
Although all PC makers moved to greater Internet sales by 2005, they
comprise only 5% for Apple, Gateway and HP with greater share for IBM
(12%) and Dell (27%). Gateway actually went down in its Internet share
between 2000 and 2005.
Dell, which was 100% direct in 1995, has remained largely direct with 27% of
sales from the Internet. Dell has begun to use value added resellers and
system integrators (6%), mainly for the SME market where its own direct
sales force is too expensive and retail is not equipped to serve it.
10
Hewlett-Packard, which was 100% indirect in 1995, has become nearly 30%
direct in 2005, partly by acquiring Compaq, which had established a direct
sales business. The ratio of retail to VAR/SI shifted from 2:8 to 5:2.
Apple moved the farthest towards engaging in its own market-making activity.
Whereas only 11% of shipments were direct in 1995, 48% were direct by
2005. This change was largely through its own retail stores and telesales
rather than the Internet.
Gateway migrated from nearly 100% direct to mainly retail collaboration
(67%), after its acquisition of eMachines and introduction of Gateway brand
products into large retail outlets. In between 1995 and 2005, it opened and
then closed over 200 of its own Gateway Country Stores in an unsuccessful
market-making strategy.
These individual patterns illustrate that the industry remains dynamic with each
firm seeking relative advantage through different combinations of direct and
indirect approaches to market making.
IV. Market making activities by PC makers
Two fundamentally different market making approaches to customer and supplier
markets underlie the direct and indirect channels: supply push in the indirect
channel and demand-pull in the direct channel (Table 4).
Individual firm
innovations also resulted in variations of these approaches.
Market making through the indirect channel historically followed a supply-push
approach to both customer and supplier markets (Table 4, column 2).
For
customer markets, vendors decided what products to offer to customers,
developed sales targets for regions, supplied the products to distribution and
provided high margins to retailers and value added resellers to push the product
through their own advertising and sales campaigns. The vendor also provided
11
umbrella advertising for its brand and products, and protected the channel
through price protection to retailers who had to discount to move inventory.
Table 4. Market making activities in PC industry
Market making
activities
Customer
markets
Market & product
definition
Indirect
(Supply-push)
Direct
(Demand-pull)
Hardware and software, e.g.,
HP/Compaq
Hardware, software and a
“relationship,” e.g., Dell
Capture
customers
Vendor provides the box;
retailers and resellers offer
“value beyond the box:” touch
& feel, additional software,
services
Vendor develops brand;
retailers do advertising
Vendor offers custom box and
relationship through vendor direct
sales force, inbound & outbound
call centers
Vendor develops brand, makes
sales calls to capture customers
Develops customized web site,
offers PC services to lock in
customers
Incentives & risk
Incentives for channel
partners, but vendor takes
inventory risk
Collaborative variation
involves shared risk by retailer
and vendor
Vendor & suppliers bear risk; no
retail
Demand
management
Only what is in inventory.
Retailers can push products
with advertising and sales
Can match demand and supply;
can shape demand
Vendor designs product,
procures key components,
manages supply chain
Vendor designs product, procures
key components, does final
assembly, manages logistics and
distribution centers
Supplier markets
Product
management
Outsourcing
Development, mfg., assembly, Development, mfg., support
logistics, distribution, support
IT-based supply Vendor supply-push; IT critical
chain
for supply chain mgt.
management
Customer demand-pull; IT critical
for demand signals & supply chain
mgt.
12
For supplier markets, vendors developed quarterly sales forecasts, placed orders
for systems/components to suppliers and required them to keep a 45-60 day
inventory in the vendor’s regional distribution centers to reduce the risk of stockouts.
Both vendor and supplier bore substantial inventory risk if the sales
forecasts were high because another 45-60 day inventory was already in the
supply chain. In recent years, vendors have made significant improvements in
supply
chain
management,
with
techniques
such
as
vendor-managed
components inventory, supply hubs close to the assembly site, and
interorganizational IT systems to coordinate with suppliers. As a result, indirect
vendors have seen significant improvements in inventory turnover and other
measures of supply chain efficiency. Today, the indirect model continues to be
an important way to reach markets, particularly consumer and SME markets, and
in developing countries without adequate information and transportation
infrastructure to support direct sales.
The collaborative variation on indirect market making emerged as a response to
problems with the indirect channel in managing demand and controlling inventory
between the PC maker and end customer. By making quarterly commitments to
sell predefined quantities, the retailer takes the market risk. In turn, the PC
maker is able to incorporate the latest components into new designs each
quarter in order to have a fresh supply of new products.
The quarterly
commitments enable the PC maker to provide accurate forecasts of demand so
there is no inventory in the supply chain. These commitments also enable better
forecasting of long-term demand by the PC maker, which in turn gives them
greater price leverage with the ODMs and suppliers who can see the potential
volume of business.
In addition, the PC maker is able to provide umbrella marketing for its retail
partners and to mount joint advertising campaigns to promote sell-through of all
product with the retailers. For example, eMachine’s collaborative model, which
focused on market making with large electronics retailers, was also adopted by
13
Gateway when it acquired the firm. A similar approach has been taken by HP for
its HP and Compaq brand PCs, which are the biggest sellers by far in the U.S.
retail market.
As will be seen in Section VI, the collaborative model was
emulated outside the U.S. by the German PC maker Medion who collaborated
with the very large supermarket chains and mass retailers in Europe.
In contrast to the supply push approach, the direct model involves a demand-pull
approach to market making (Table 4). For customer markets, vendors promote
customization (build to order), standardization (download of corporate standard
software to all PCs) and low cost, especially to commercial customers (business,
government, education) to attract their business. Vendors take orders through
their own direct sales force, call centers or the Internet, giving vendors direct
understanding of customer demand and the ability to detect new market trends
early. The direct relationship also enables the vendor to up-sell customers by
offering related products at low cost (computer plus printer, monitor, training and
service), sell components that are in inventory by offering discounts, and shape
demand by offering newer technologies at the same price as current ones.
Vendors develop advertising to build brand image, promote specific products and
drive customers to their web sites and call centers. A substantial direct sales
force and “executive centers” are also used to promote large commercial
contracts. For example, Dell has executive centers located at manufacturing
plants whose purpose is to sell customers on the Dell model and Dell’s execution
of it through briefings, an in-plant tour and an informal lunch or reception with
Dell executives and staff (Dell interview 2000).
Commercial contracts usually involve thousands and frequently tens of
thousands of PCs to be delivered over several years, which have major
implications for supplier markets. Vendors are able to forecast demand better,
plan production, and negotiate prices with suppliers based on known demand.
Because PCs are built to the customer's order and delivered direct as a complete
package, there is no inventory in the distribution channel. Inventory in the supply
14
chain also can be reduced through the use of IT to better forecast demand and
plan production. And because the vendor controls final assembly and logistics, it
can better ensure product quality and timely delivery even when parts of a
complete system (e.g., monitors or peripherals) are shipped direct to the
customer from suppliers’ factories.
The result is a brand image of low cost, customization and advanced technology
which helped propel Dell to be the industry leader for commercial markets, and
for a while, Gateway to be a leader for direct sales to consumer markets. Dell’s
success forced other major PC makers to emulate its market making strategy by
developing direct capabilities.
Although Dell retains the lead on most
performance measures, emulation and process innovation by other vendors has
resulted in closing the performance gap.
Market making by others
A special feature of the PC industry is that technical standards are set by key
component and software suppliers, who engage in market making activities to
promote their own brand and products, and who both cooperate and compete
with the PC makers.
Intel develops reference designs for PCs based on each new processor and chip
set that it introduces. These standard designs reduce the ability of branded firms
to differentiate based on technical architecture, while also making it easier for
non-brand firms (white box makers) to compete with the branded firms by simply
following the standard.
Intel also provides technical assistance (engineering,
training, testing services) to the white box makers which are mostly small and
medium-sized firms without engineering staffs (Tzeng and Lang, 2003; Chan,
2005; Yeo, 2006). Intel cooperates with the branded PC firms by providing funds
for its “Intel Inside” co-branded labeling, marketing and advertising, but also has
its own marketing and advertising programs to promote the Intel brand. These
15
activities are designed to increase Intel’s market power and to keep the branded
PC makers in line, while cooperating with them in joint marketing efforts.
Intel is not alone. Microsoft also funds co-branded marketing and advertising for
PC makers as well as manufacturers of non-PC devices that run on its operating
systems (e.g., phones and PDAs). Its own advertising for Windows products
promotes retail sales of its operating systems, but also helps drive sales of new
PCs to take advantage of the capabilities of its software.
These activities are a double edged sword from a market-making perspective.
The Wintel standard helped to make the PC market through standardization of
hardware and software interfaces and greater interoperability of PCs, which is
increasingly important in a globally interconnected world.
Branding and
advertising programs also increased the overall demand for computing through
greater public awareness and stimulation of demand. However, these programs
also reinforced the monopoly power of Intel and Microsoft, enabling them to keep
prices high and to punish PC makers who stray from the standard (e.g., use AMD
chips or promote open source software) by supporting their competitors
(retailers, white box makers). We would argue that Intel and Microsoft could
have a greater effect on demand simply by cutting their prices, enabling vendors
to reach more customers, particularly in big emerging markets such as China,
India, Brazil and Mexico.6
V. Impacts of market making on customers and suppliers
The impacts of market making by PC makers and others have been largely
positive for customers while quite mixed for suppliers.
6
Although admittedly, many customers in those countries already pay close to zero for Windows, and for application
software, given high piracy rates.
16
Customers
Consumers are offered a richer variety of purchasing options thanks to the
innovation in market making by the PC industry. They can shop and buy online,
or window shop online and buy in a vendor’s retail store, or choose from a
number of physical retail outlets.
The ability of PC makers and retailers to
eliminate excess inventory also means lower prices and fresher products with the
most recent technologies.
Consumers also benefit from more product
information and the ability to compare prices online, even if they shop in person.
However, consumers now have fewer choices of retail PC brands, as a result of
mergers (HP-Compaq, Gateway-eMachines, Lenovo-IBM), and the exit of brands
from the U.S. market, such as AST, Packard Bell and Acer (which is just
returning to the U.S. market).
HP (including its Compaq brand) controls over
half of the in-store retail PC market, with only Gateway, Sony and Toshiba as
major competitors in the U.S. Yet given the rapid introduction of new products
and ever lower prices, it is hard to argue that consumers are suffering from this
consolidation.
Commercial customers reap all these consumer advantages and more. With
build to order procurement and systems that download corporate approved
software and system images and the ability to migrate to newer technologies that
come along for the platform, large firms can more easily manage PC resources
from
procurement
to
disposition.
Furthermore,
they
achieve
greater
standardization of platforms. Small and midsize businesses (SMBs) can acquire
installation and maintenance services through channel partners (VARs and SIs)
or through white box makers as well as from their vendors.
Suppliers
The PC makers’ market-making activities that led to industry consolidation also
increased their market power over their ODM/CM contractors and the entire
17
supply chain. It impacted the industry structure, the way firms must do business,
the roles they perform, and their prices and profits.
Industry structure. The branded PC makers reduced the number of suppliers
they do business with, resulting in a two-tier supplier structure of very large and
midsize-to- small firms. Although they use fewer contractors and engage in long
term relationships with them, the PC makers still shift contracts for specific
products among suppliers based on cost, quality, or unique capabilities (Dedrick
and Kraemer, 2006).
Doing business. PC makers have adopted just-in-time supply hubs and vendorowned inventory to reduce inventory costs. Contract manufacturers are pushed
to provide direct shipment services. In some cases, the PC maker never takes
physical possession of the product, which is built by outside suppliers and
shipped directly to the end customer or retailer. The exception is build-to-order
assembly, which Dell and others keep inside their own factories (Kraemer et al.,
2000). However, IBM/Lenovo outsourced build-to-order production in the U.S.
and Europe, and Apple did the same in the U.S. so there appears to be no real
barrier to complete outsourcing of manufacturing.
Supplier Roles. As PC makers shifted their focus from manufacturing to
retailing/market making, their suppliers have taken on new roles. Original Design
Manufacturers, mostly Taiwanese companies who design and manufacture PCs
for all of the major PC vendors, now:
x
Do new product development, especially for notebook PCs.
x
Provide warranty and repair services in some cases.
As these suppliers gained capabilities, the PC makers were able to concentrate
on marketing, branding, product management, and supply chain coordination.
The production model pioneered by the PC industry has been adopted to varying
degrees in other parts of the electronics industry as well. Contract manufacturers
18
and ODMs have taken over more manufacturing and parts of the design process,
especially for lower end and more mature products.
Typically, contract
manufacturers have specialized in efficient production, logistics and related
services for a wide range of products such as printers, network equipment,
iPods, and video games.
But for some products, such as cell phones, joint
development with ODMs is becoming more common. However, the outsourced
manufacturing and development approach is little used by Japanese and Korean
firms who are still much more vertically integrated than US firms.
Prices and Profits. The biggest impact of market making on suppliers, for both
the direct and indirect model, is the constant pressure from PC makers to cut
costs to meet industry competition. Dell’s efficient direct model enabled it to
lower prices. Other vendors had to match prices by greater use of outsourcing
and continual pressure on suppliers to cut costs. Vendors force the ODMs to
compete with one another for business and expect quarterly cost reductions of 57%.7 Suppliers go along with these practices in the hopes that lower prices
would grow the market and enable them to gain economies of scale. Low profits,
on the order of 1-2%, led some ODMs to integrate forward and to develop their
own brand products, while others moved upstream to produce components and
subassemblies. The result for the PC industry is a continual increase in the
number of units sold, but only a modest increase in sales revenue, and a
continual decline in profits for both PC makers and suppliers. The exceptions are
Microsoft and Intel, who continue to enjoy rich margins, leading PC makers and
suppliers to complain that they’re killing themselves to make money for Microsoft
and Intel.
VI. The global picture
Outside the U.S., the market-making picture is quite different. The direct sales
model for PCs has only been successful in some markets. For example, Dell’s
7
Numbers based on field interviews with ODMs and suppliers by the authors.
19
market share is 35% in the U.S., but only 18% worldwide (IDC, 2006).
Comparison of the U.S. and worldwide trends shows growing use of the direct
model generally, but that the indirect model still dominates outside the U.S.
(Table 5).8 Moreover, the rest of the world tends to use dealers, VARs or system
integrators more than retailers regardless of region (Appendix A).
Table 5. Worldwide PC shipment share by channel (units)
Channel
1995
2000
2005
Direct*
21.70%
27.90%
33.70%
Direct Inbound
9.58
11.65
9.50
12.12
12.80
18.86
.00
3.45
5.34
Indirect
78.30
72.10
66.30
Retail
24.11
29.80
28.60
Dealer/VAR/SI
49.22
39.68
35.39
4.97
2.62
2.31
Direct Outbound
Internet Direct
Other
Source: IDC, 2006
*Direct sales include: (1) sales by customer-initiated inbound calls, (2) sales by a feet-on-the-street sales force, and sales
by vendor-initiated outbound calls, (3) sales made strictly online directly by the end user with no human interaction from
the vendor.
**Indirect sales are those sold through a distributor, aggregator, system integrator, value added reseller, mass merchant,
or retailer, including vendor-owned retail stores.
This broad pattern for the leading non-U.S. PC makers is also illustrated in the
evolution of individual firms from 1995-2005 (Table 6). Four of the five leading
Asian brands (Acer, Fujitsu, Lenovo and Toshiba) use VAR/SI over retail. Sony
uses retail, including its own Sony Style stores, over VAR/SI and shows
increasing use of the Internet. As with U.S. firms, the leading non-U.S. vendors
use different mixes of direct and indirect strategies for their markets, though still
mainly indirect.
8
Indirect sales worldwide are over 66% of total sales; excluding the U.S., the figure would be much higher.
20
Table 6. Non-U.S. PC makers as retailers: percent of shipments by model
(%)
Vendor
Indirect model
Retail
Direct model
1995
2005
Value-added
reseller/System
integrator
1995
2005
Vendor-direct
Pure Internet &
sales force & 3rd party Internet
telesales
1995
2005
2000
2005
Lenovo
-
1
-
56
-
37
-
6
Acer
31
3
67
96
3
0
10
0
Fujitsu
-
10
-
64
23
5
3
Sony
-
49
-
33
-
5
10
13
Toshiba
56
-
44
-
0
-
2
-
Source: IDC, 2007
The VAR/system integrator channel dominates outside the U.S. because most
countries do not have the large nationwide retailers as in the U.S. (as illustrated
in earlier chapters), or national distribution networks.
Moreover, neither
commercial customers nor consumers are accustomed to buying by phone or
over the Internet (Kraemer et al., 2006). As a result, local retail models differ
among countries.
We label this difference generally--“retailer as PC maker.”
Some countries, such as Japan, use traditional two-tier channels, with local
retailers dominating as illustrated by the “electronics district” in major Japanese
cities (e.g., Akihabara in Tokyo). Others with strong domestic PC brands (such
as NEC and Fujitsu in Japan, Samsung in Korea and Lenovo in China), are
marked by vendor-dominated nationwide networks of dealers who only carry
those brands. In Brazil, local brands are sold in supermarkets and other nontraditional retail outlets. In Europe, the German company Medion decided to
leverage the already established but unexploited mass-market retailer chains,
such as food retailers, supermarkets and discounters (e.g., ALDI, Carrefour, and
Metro) to sell PCs to consumers—a model similar to eMachines (Ordanini et al.,
2006). In many developing countries, small “white box” makers have up to half
21
the market. They buy assembled notebooks from the ODMs, assemble desktops
themselves, and install PCs for consumers and small businesses.
These differences suggest multiple models in different places rather than an
emerging global model for PC or consumer electronics retailing. Market making
for PCs is almost always local and must be done through local distribution
networks. The need for localization is also a reason why many vendors or their
contract manufacturers must keep some local final assembly capabilities, and/or
very sophisticated supply chain and logistics systems. Because other markets
are much less PC-centric than the U.S. and more focused on wireless
technologies and games (Japan, Korea, China), the power of mobile service
providers and interactive game services is greater. In their case, the focus is on
the service rather than the sale of the hardware per se.
Under these circumstances, the branded PC and consumer electronics makers
or retailers in the U.S. face significant hurdles if they are to become truly global
market makers. Moreover, it is in the interest of the core technology standard
setters such as Intel to limit the market power of any would-be global market
maker. Standards issues become even thornier on a global level. Governments
and local actors become involved and often different standards prevail in different
countries. While the Wintel standard became a de facto global standard, there
are, and will be, multiple standards for 3G cell phones, DVDs, wireless
networking and many other technologies. As we move into the next phase of the
PC and consumer electronics industries, we may see more fragmentation of
market making rather than more standardization, with the fragmentation aided by
governments and technology alliances among competing groups of companies.
VII. Future trends in market making
Systems Integration. The trend which is likely to most significantly redefine the
PC and Consumer Electronics industries, and the nature of market making in
22
those industries, is the proliferation of technologies with the potential to be
interconnected in the “digital home.”
Consumers no longer buy PCs, TVs,
cameras or audio systems as separate items with separate functions. Instead
they store digital photos on PCs, download music from PCs to iPods, save TV
shows on PCs, and play movies on portable DVD players. And now they are
listening to music and playing games on cell phones. The challenge is getting
these technologies to work together, which has proved to be a big hurdle for
consumers, retailers, and technology companies.
Convergence.
Partly because of the systems integration hurdle and also
because of competing visions, the PC-centric orientation of the PC industry is
being challenged by network-centric and PC-independent visions. The networkcentric idea is that user applications and content will be stored on the Internet
and accessible from anywhere with a variety of devices such as an MP3 player,
PDA, phone, or PC—but the PC will no longer be central. The PC-independent
vision is that the functionality of a PC will be built into some consumer electronic
devices such as TVs, set-top boxes and DVRs (e.g., Tivo) and therefore no
longer require a media center PC. It is unclear which of these visions (or some
other) will hold sway in the future, but it is likely that the PC will play a significant
role in convergence.
Apple’s music service illustrates such convergence. What is being sold is an
entertainment ecosystem rather than just an MP3 product. Apple integrated an
independent device (the iPod) with the PC (Mac or Wintel). The iTunes software
provides the capability to download songs stored on the network (the Internetbased iTunes Music Store), to manage a music library, to play songs and to
transfer them to the iPod. Apple needed to keep tight control over the hardware,
software, and electronic commerce components in order to make a market for
digital music. HP tried to do the same with digital photos, but it had to be more
open in allowing interconnection with competing camera, PC and printer brands.
23
Apple is trying to extend the iPod success with the iPhone, which adds
communication capabilities and phone carriers to the ecosystem.
Technology integration and new services. For retailers, the issue is providing
customers with the help they need to get the technologies to work together. The
integration challenge creates new opportunities in market making. Firms that can
make the disparate technologies work for consumers will have a new role as
market makers. Attempts to do so include Best Buy’s Geek Squads (Krazit,
2006) or Circuit City’s Firedog service (Reuters, 2006), which make house calls
to get balky systems to work, and Apple’s in-store experts who will show
customers how to use the products they sell.
Given that the digital home
incorporates products from multiple computer and electronics companies,
retailers are in a good position to be market makers if they can develop the
needed expertise. Sensing this situation as an opportunity, the distributor Ingram
Micro is developing a new business based on providing support to these
emerging digital home integrators.
Standards. At the technology end, the big issue is standards. Here the problem
is that companies need to establish standards for products to work together, but
some hope to capture monopoly profits by having their own standards adopted.
Also, no one wants to cede power and profits to a future Microsoft or Intel. The
result is often years of delay in introducing technologies, or a profusion of
standards that don’t work together in the home. In the PC industry, Microsoft and
Intel set the standards and everyone else (except Apple) went along. In the
digital home era, everyone from Microsoft and Intel to Sony, Toshiba, Nokia,
Cisco and even Yahoo! and Google are all trying to set standards. PC makers
who don’t create technologies are left in the position of lining up on one standard
or another, or supporting multiple standards, and hoping to be right. Retailers
are in the same position, as no retailer has the market power to determine
standards by its own choice of what to carry.
24
The choice of vision. It is likely therefore that future market making will include
PC-centric, network-centric and PC-independent visions, perhaps with a mix of
these visions for individual firms. While market making in the PC industry
historically was focused on the commercial market, which led the consumer
market in adopting new technologies, now it is the consumer market that leads.
This dramatically changes the nature of market making, as individual consumers
can have much different motivations than corporate IT departments. Consumers
care about style, ease of use, convenience and service and do not get enjoyment
or job security from getting technologies to work together. Thus, the future of
market making will be driven more by those who understand the customer and
less by those who create the technology.
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27
Appendix A–Channel shares of PC shipments by world regions
Table A-1. Asia Pacific PC shipment share by channel (units)
Channel
1995
2000
2005
Direct
25.77%
16.40%
16.60%
.56
1.32
2.33
25.21
13.19
12.89
.00
1.89
1.38
Indirect
74.23
83.60
83.40
Retail
13.64
30.18
32.61
Dealer/VAR/SI
60.16
52.43
49.97
.43
.99
.82
Direct Inbound
Direct Outbound
Internet Direct
Other
Source: IDC, 2006
Table A-2. Latin America PC shipment share by channel (units)
Channel
1995
2000
2005
Direct
20.85%
28.32%
40.43%
3.39
4.57
5.95
17.46
22.21
32.93
.00
1.54
1.55
Indirect
79.15
71.68
59.57
Retail
8.01
23.59
18.95
65.60
45.11
38.64
5.54
2.98
1.98
Direct Inbound
Direct Outbound
Internet Direct
Dealer/VAR/SI
Other
Source: IDC, 2006
28
Table A-3. Western Europe PC shipment share by channel (units)
Channel
1995
2000
2005
Direct
17.12%
16.74%
22.48%
Direct Inbound
10.27
9.00
10.03
6.85
6.66
10.36
.00
1.08
2.09
Indirect
82.88
83.26
77.52
Retail
22.80
32.60
34.47
Dealer/VAR/SI
58.39
48.45
40.38
1.69
2.21
2.67
Direct Outbound
Internet Direct
Other
Source: IDC, 2006
Table A-4. Central/Eastern Europe PC shipment share by channel (units)
Channel
Direct
1995
2000
2005
20.61%
23.60%
21.21%
.37
.41
.40
20.24
22.99
19.64
.00
.20
1.17
Indirect
79.39
76.40
78.79
Retail
12.29
31.25
33.69
Dealer/VAR/SI
67.05
45.08
45.07
.05
.07
.03
Direct Inbound
Direct Outbound
Internet Direct
Other
Source: IDC, 2006
29
Table A-5. Middle East/Africa PC shipment share by channel (units)
Channel
1995
2000
2005
Direct
26.23%
25.61%
29.05%
1.04
1.69
.42
25.19
23.06
28.16
.00
.86
.47
Indirect
73.77
74.39
70.95
Retail
6.27
8.50
21.01
67.50
63.41
49.82
.00
2.48
.12
Direct Inbound
Direct Outbound
Internet Direct
Dealer/VAR/SI
Other
Source: IDC, 2006
Source for all tables: IDC, 2006. Data compiled on request by Hardware Channels and Alliances, IDC
January 23, 2006.
